Development of a Project Management Methodology for Supporting Mergers & Acquisitions (M&A)

(1)

i

Kungliga Tekniska Högskolan Royal Institute of Technology

Industrial Economics and Management

Politecnico di Milano Industrial Management

Universidad Politécnica de Madrid Escuela Técnica Superior de Ingenieros Industriales

Development of a Project Management Methodology for Supporting Mergers & Acquisitions (M&A)

FABIO SOTTILI CHAVES

Thesis ID: 2012:141

Supervisor: Javier Sánchez

7

^th

Edition 2010-2012

Master of Science Thesis

Stockholm, Sweden 2012

(2)

(3)

We learn wisdom from failure much more than from success. We often discover what will do, by finding out what will not do; and probably he, who never made a mistake, never made a discovery.

- Samuel Smiles

(4)

Abstract

Mergers and Acquisitions (M&A) are strategic tools at disposal of CEOs to accelerate growth and achieve objectives faster, as long as they are successfully implemented. In the last 100 years, plenty of examples both of successful and failed M&A attempts are available in the literature.

Professionals in the area agree the best way to conduct M&A is through a project. Conducting a project requires a solid, purpose-build methodology to significantly increase the chances of success. Despite this fact, publicly available management methodologies for M&A projects are rare, as most methodologies are proprietary, thus owned by consulting firms and not openly available. This gap motivates the development of a project management methodology tailored to M&A undertakings. Such methodology is intended to serve both professionals already active in the area as well as beginners willing to get familiar with the fantastic realm of M&A.

This work proposes a methodology based on a framework which presents, in one single picture, all the knowledge areas involved in conducting an M&A project. Besides, the project is split in phases and stages set in a temporal dimension and obeying dependencies to set the sequence in which processes in each knowledge area are applied. Each knowledge area and phases are extensively explained along with real examples to facilitate learning. Phases and stages are also diligently covered.

The result is a simple, yet comprehensive methodology to support the undertaking of M&A projects. It is generic enough to be further developed and tailored to more specific needs.

Notwithstanding, it is a great source of knowledge in the area for those interested in having a high-level overview of what M&A are about.

The major implication of this work is delivering a publicly available Project Management methodology tailored for M&A undertakings, serving as a comprehensive overview of what Mergers and Acquisitions are, best practices in the field and how such an undertaking can be successfully carried out.

Keywords: Mergers & Acquisitions (M&A), Project Management, Marketing, Finance, Project Management Office (PMO), Corporate Strategy

(5)

Acknowledgements

Behind any great contribution there are great people who agreed to sacrifice their own interests and wishes to make this work possible. I am immensely grateful to each one of them for their contribution, small or big, on the personal or professional sphere to support me through this journey.

I´d like first of all to thank my parents, Sérgio R. Chaves and Elisabete Sottili Chaves and my brother Rafael Sottili Chaves for their continuous and unconditional support, for cheering me up to continue despite so many uncertainties and difficult moments in my life. For my grandparents, Pedro G. Sottili, Enely Sottili, Maria Chaves and Bernardino Chaves (in memoriam) for being proud of my achievements. For all my uncles, aunts and cousins, especially Luiz Carlos Sottili (in memoriam) and Victor Sottili (in memoriam) for living long lasting memories in our family and who always believed in my capacity.

I had the pleasure and opportunity to have met outstanding colleagues and professionals who inspired me to grow and acted as mentors and gave me the guidance and courage to get through good and bad moments: John Elder, Ehab Rofaiel, Onfrej Benjik, Noel Peberty, Gus Finucci, Aly Shawky and Anna di Stasio. My special thanks to Duncan Curd and Kayomars Bajina for their mentorship and availability whenever I needed them.

Thanks to the many friends whom I had to leave behind to pursue this Masters, for the encouragement and the many good wishes: Shauna Wallace, Christina Dinis and Juan Carlos Calderon. And to Anne Larsson for her company in Europe.

I cannot miss the opportunity to thank Bonnie McLachlan for making my life in Canada so memorable, despite the short time she was present in it, and for encouraging me in following this Masters despite her personal loss. Thank you a lot for being present and support me in some of the best and yet difficult moments in my life and for cheering with me in all my conquers.

And of course I´d like to thank my IMIM colleagues for the wonderful time we spent together in these 2 years: the sangrias in Madrid, the countless espressos in Como, the common meals and parties in Lappis. Thanks Warut Wattarnusart and Felix Damrath for the company during the long days in the library while writing this thesis. Thanks Amir Gershon for the awesome ski trips and emptied bottles of wine over dinner in Como.

And last, but not least, a big thank you for the Erasmus Mundus Consortium for the outstanding program and the opportunity offered to embark on this journey. Besides the financial support, the Consortium offered a unique opportunity to advance my knowledge, Opening new doors on the professional side. A special thanks to Javier Sanchéz for his support and guidance in writing this thesis.

Stockholm, June 2012

(6)

List of Figures

Figure 2–1: Relationships between narrow and broad meaning M&A. Adapted from Nakamura

(2005) ... 5

Figure 2–2: Relative risk level (mainly risk of failure) among the many business strategies ... 12

Figure 2–3: Value chain representation ... 14

Figure 2–4: Example of Corporate Governance Structure ... 15

Figure 2–5: How synergy translates into increased company value (McKinsey et al., 2000) ... 20

Figure 2–6: Product-market diversification (DePamphilis, 2011: 6) ... 30

Figure 2–7: Project Management Framework. Adapted from (Madras, 2008: 24) ... 37

Figure 2–8: The triple constraint (Madras, 2008: 21) ... 38

Figure 2–9: Example of a Portfolio ... 41

Figure 2–10: How (Kerzner, 2001: 100) suggests the relationship between PMO and PM-CoE ... 46

Figure 2–11: The competence continuum range in Project Management ... 46

Figure 2–12: Enterprise PMO, adapted from (Caruso, 2010) ... 50

Figure 2–13: Example of an EPM solution, adapted from (Perry, 2009: 172) ... 52

Figure 2–14: Project Management Maturity progression, adapted from (Kerzner, 2001: 42) ... 54

Figure 2–15: Project lifecycle periods and respective costs and labour efforts (Project Management Institute, 2008) ... 55

Figure 2–16: Sequential phases in a project ... 56

Figure 2–17: Overlapping project phases ... 56

Figure 2–18: The various stakeholders in a project ... 57

Figure 2–19: Dimensions of organizational culture (Robbins, 2006) ... 58

Figure 2–20: Product-based and geographically-based functional structures (Ritson, 2011: 11) . 59 Figure 2–21: Example of strong matrix structure (Ritson, 2011: 13) ... 59

Figure 2–22: Example of projectized structure (Project Management Institute, 2008: 31) ... 59

Figure 3–1: Deduction, induction and abduction approaches ... 62

Figure 3–2: The research onion, adapted from (Saunders, Lewis and Thornhill, 2009: 108) ... 63

Figure 3–3: The research methodology chosen by the author for this work ... 64

Figure 4–1: “A”´s Corporate Governance Structure ... 66 Figure 4–2: The Company Strategic Framework, adapted from (Kaplan and Norton, 2004: 33) . 68

(11)

Figure 4–3: The Strategy Map for 2012-2014 at “A Limited” ... 69 Figure 4–4: Balanced Scorecard and Action Plan for “A Limited” ... 71 Figure 5–1: Six stages segmented in the nine main activities ... 74 Figure 5–2: Temporal representation of the 6 stages and their implementation through 4 projects phases ... 75 Figure 5–3: The M&A Project Management Framework ... 77 Figure 5–4: CRIM Framework. Adapted from (McGrath, 2011: 88) ... 90

Figure 5–5: Brand Relationship Spectrum architecture with examples.

Adapted from (Acker and Joachimsthaler, 2000) ... 93 Figure 5–6: Before and after supply and distribution networks re-engineering ... 118

(12)

List of Tables

Table 2-1: Valuation methods (Frykman and Tolleryd, 2010: 27) ... 21

Table 2-2: Relative Enterprise Multiples, adapted from (Frykman and Tolleryd, 2010: 46-71) .. 26

Table 2-3: Fundamental Enterprise Multiples Calculation, adapted from (Frykman and Tolleryd, 2010: 46-71) ... 26

Table 2-4: Most used relative equity multiples ... 27

Table 2-5: Most common fundamental equity multiples ... 27

Table 2-6: The game of P/E (Weston and Weaver, 2004: 89) ... 32

Table 2-7: Effects on acquirer and target companies (Weston and Weaver, 2004: 90) ... 32

Table 2-8: Project management processes listed per process groups and knowledge areas, adapted from (Project Management Institute, 2008: 43) ... 39

Table 2-9: Comparison of key aspects in projects, programs and portfolios. Adapted from (Project Management Institute, 2008: 9) ... 44

Table 2-10: Differences between PMO and PM-CoE from (Kerzner, 2001: 100) ... 45

Table 2-11: Differences in the naming assigned to each maturity level as per Dr. Kerzner and SEI ... 54

Table 5-1: Process groups and knowledge areas in the new M&A framework ... 79

Table 5-2: The different ways of financing an M&A transaction ... 84

Table 5-3: The impact of marketing in branding – before and after M&A (joint-venture, merger and acquisition in this order) ... 94

Table 5-4: The tripe-constraint consideration for each project phase. Adapted from (McGrath, 2011: 110) ... 105

(13)

List of Acronyms

B2B Business to Business B2C Business to Customers

BPM Business Process Management

BU Business Unit

CAGR Compounded Annual Growth Rate CAPEX Capital Expenditures

CEO Chief Executive Officer CFO Chief Financial Officer CFR Code of Federal Regulations CFROI Cash Flow Return on Investment CIO Chief Information Officer CoC Change of Control COGS Cost of Goods Sold

CPG Consumer Packaged Goods

CRM Customer Relationship Management CTO Chief Technology Officer

DCF Discounted Cash Flow DDM Dividend Discount Model EBIT Earnings Before Interest Taxes

EBITDA Earnings Before Interests, Taxes, Depreciation and Amortization EDI Electronic Data Interchange

eHACCP Electronic Hazard Analysis and Critical Control Points EPM Enterprise Project Management

ERP Enterprise Resource Planning

EV Enterprise Value

EVA Economic Value Added

FASB Financial Accounting Standards Board FDA Food and Drugs Administration

(14)

FTC Federal Trade Commission

GAAP General Accepted Accounting Practices GAMP Good Automated Manufacturing Practices GMP Good Manufacturing Practices

HACCP Hazard Analysis and Critical Control Points HMI Human Machine Interface

HRM Human Resource Management

IMIM International Masters in Industrial Management IPO Initial Public Offering

IT Information Technology KPI Key Performance Indicators

LIMS Laboratory Information Management System M&A Mergers & Acquisitions

MOM Manufacturing Operations Management

MV Market Value

NAV Net Asset Value

OEE Overall Equipment Effectiveness OEM Original Equipment Manufacturer OPEX Operational Expenses

OpFCF Operational Free Cash Flow P&G Procter & Gamble

P/BV Price to Book Value Ratio P/E Price to Earnings Ratio P/E Price-Earnings Ratio

PEG Price to Earnings to Growth Rate Ratio PIMS Product Information Management System PLM Product Lifecycle Management

PM Project Management

PMBOK Project Management Body of Knowledge PM-CoE Project Management Centre of Excellence

(15)

PMI Project Management Institute

PMIS Project Management Information System PMO Project Management Office

PMP Project Management Professional

PO Purchase Order

R&D Research and Development ROA Return on Assets

ROE Return on Equity

ROI Return on Investment ROIC Return on Invested Capital

S.M.A.R.T. Specific, Measurable, Achievable, Results oriented, Time-bound SaaS Software as a Service

SCM Supply Chain Management SEI Software Engineering Institute

SG&A Selling, General & Administrative Expenses SOW Statement of Work

TCO Total Cost of Ownership

US United States

VP Vice-President

WACC Weighted Average Cost of Capital

(16)

1. Introduction

In the globalized economic climate we currently live in, shareholders and investors alike normally expect more than the single-digit growth achieved through organic means. Chief Executive Officers (CEOs) need to be creative in attracting investments to finance growth in such competitive market landscape. The sharp reduction in the product lifecycles requires intense investments in Research and Development (R&D), state-of-the-art production facilities, suppliers who are actually partners, and nimble distribution channels to deliver innovative and customer-delighting products as fast and cheap as possible. The capital markets, the main source of funds, require quick turnaround through high return on invested capital (ROIC) to provide you the funds you need. One alternative to break this cycle is through Mergers and Acquisitions (M&A).

There are few activities in the world of business that can match MA& in terms of opportunity to transform, potential for reward and risk of failure (McGrath, 2011: 3).

Given the magnitude of many M&A deals, they have the power to either put the CEO on a pedestal or put him out of his/her job.

To some extent, a merger can be roughly compared to an ordinary marriage¹. The phase leading to the proposed engagement or merger is filled with uncertainties and excitement – both are getting to know each other and assessing whether they can build a future together – congruency of long-term goals and mutual expectations, i.e. whether there is a fit. Then the pre-marriage (pre-merger) phase comes bringing all the many tasks leading to the official marriage (merger). Consummating the act by signing papers is the easy and quick part. The challenge comes after the ceremony, when both need to behave as one entity, working out the differences to, integrated, work towards common goals. As many factors could not be foreseen before the marriage or merger, such post-integration discrepancies turn up, often making the union to fail. Such failure can be in form of a demerger or bankruptcy. All the aforementioned phases require motivated, well-versed and disciplined people following a well-structured approach to pull the entire “deal” diligently together.

Chances are you agree with the fact that both marriage and merger processes are unique², time-bounded, phase-driven, which involve human resources and require different capacities (or knowledge areas). Then, as a consequence both processes can be considered a project.

Considering a merger or acquisition as a project, the likelihood of success can be significantly increased by using a proper project management methodology and skills.

Merger and Acquisitions can range from small deals, such as integrating two local supermarkets, to multi-billion dollar global mergers, involving companies in different continents, different currencies, complex and sometimes contradictory legal frameworks, opposing management styles and company cultures.

1 Consider a marriage in the western world. The comparison is for illustrative purpose only!

2 Changing one or both the groom and the bride will inevitably change the institution (the marriage). The same applies to the merger of two companies.

(17)

Mergers and Acquisitions are no novelty. As it will be seen, the first appearance of such activities is dated back to late 1800s and early 1900s in the United States (DePamphilis, 2011). However, globalization incurred a major shift in the M&A paradigm: transactions went from local to global. The impact of such change cannot be underestimated.

Transactions increased in total value, magnitude and complexity, so did the possible rewards and the risks of failure and losses. Reducing such risks by diligently managing the M&A projects by applying a good methodology increases the likelihood of success and returns.

1.1. Motivation

My personal and professional ambitions with this work are:



Use the multi-disciplinary knowledge acquired in the International Masters in Industrial Management (IMIM) and my previous work experience in different countries and companies to add new perspectives to the current state-of-the-art knowledge in the area of mergers and acquisitions;



Complement my professional knowledge and skills portfolio by exploring the fascinating world of M&A;



Propose a Project Management Methodology to help others having a better understanding of what M&A entails and support advancing the current body of knowledge in this field.

M&A projects are very interesting whilst challenging endeavours, as no cookie-cutter approach fits all projects but it offers the unique opportunity to exercise nearly all knowledge areas one could enumerate in the corporate world. This is the main driver that led me to focus on this topic.

I would be immensely satisfied if my work is of use to anyone, either as a source of knowledge or applied in real M&A projects.

1.2. Problem Statement

As it will be visible along this work, conducting mergers or acquisitions requires a mix of skills, experience, science and art. It requires managerial and soft-skills to deal with both the transaction as a pile of paperwork as well as dealing with people, culture and the

“emotions” involved in laying off employees with long-tenure. It requires experience to manage time, negotiate the best deal and make quick decisions under pressure. It is a science as it involves Finance and other Engineering knowledge areas. It is art as defining a new corporate culture means dealing with people, behaviours and many other “soft”

intangible areas.

Such complexity can justify the absence of publicly available and comprehensive methodologies for M&A projects. Investment banks and consulting firms specialized on M&A transactions claim to have their own proprietary methodology in conducting such deals; however access to such material is precluded. A significant portion of such

(18)

methodologies may be on the head of their most experienced consultants, who have mastered the skills and knowledge required to pull together what is needed in such projects. There are some books available in the market providing a framework of some sort, mostly based on the professional experience of those involved in real M&A projects.

Despite their best efforts, the contents are sometimes too complex to those without the required background, or important pieces of information are withheld for many reasons.

1.3 Objectives and Research Contribution

Considering the above, the main objectives for this work are:



Propose a publicly-available Framework to support the planning, execution and delivery of mergers and acquisitions projects;



Provide readers not familiar with the topic of mergers and acquisitions with an easy- to-read and understand source of information, promoting appreciation to this exciting topic;



Give the author the opportunity to contribute to the current body of knowledge and his own understanding of the topic, which is of his professional interest.

In light of the above, the research contribution is:

Develop a Project Management Methodology to support the undertaking of mergers and acquisitions projects

1.4 Unique Contribution

As previously stated, the lack of a complete, publicly available, easy-to-read and understand whilst applicable project management methodology on mergers and acquisitions is a unique source of information to anyone interested in the topic, either for learning purposes or application in real M&A projects.

1.5 Scope and Limitations

As it will be discussed, M&A project approaches tend to differ depending on the industry or sector in consideration. This work will attempt to create a methodology generic enough to be applicable as-is or easily adapted to M&A projects in most industries. M&A in the banking sector is one example of a case in which a specially designed methodology is needed given the much higher regulatory pressure compared with other industries (McGrath, 2011). Special cases such as the latter are out of scope of this work. As an attempt to create awareness about the drivers behind M&A activities and to make the methodology more tangible and understandable, the example of two fictitious companies,

“A” and “B”, active in the Food & Beverage industry will be introduced. Considering the complexity and the highly regionalized nature of legal aspects involved in M&A transactions, they will be only superficially dealt with in this work. The geographical areas

(19)

under consideration are Latin America (Brazil), North America (US and Canada) and Western Continental Europe.

Despite the fact this work intends to develop a methodology, the development of templates, flowcharts and other guiding documents is outside of scope, as such additional material significantly increases the need to narrow down the industry served and extending the require time to beyond the time frame of a Master Thesis.

1.6 Report Outline

The report is structured in the following way:



Chapter 2: Literature review, exploring the topic mergers and acquisitions (M&A) in section 2.1 and Project Management in section 2.2. It provides the required basic background to understand the contribution of this work as well as to critically analyse the existing body of knowledge in both knowledge areas.



Chapter 3: A short case study is presented as a prelude to the contribution of this work.



Chapter 4: The chosen research methodology for this research is presented.



Chapter 5: The proposed Project Management Methodology for M&A transactions is developed.



Chapter 6: Overall results are presented and limitations exposed.



Chapter 7: Conclusions are drawn and directions for future research are pointed out.

(20)

2. Research Background

This chapter will be devoted to present a holistic view about the two main knowledge areas needed to support this work: mergers and acquisitions (M&A) and Project Management. Section 2.1 introduces the reader to the conceptual background of M&A, while section 2.2 covers the area of Project, Program and Portfolio Management.

2.1. Mergers & Acquisitions (M&A)

Mergers and Acquisitions (M&A) is an area which has been given increased interest in the last decade. The total number of M&A transactions reached its peak in 2007, only to see a steep drop during the financial crisis in 2008-2009 due to generalized lack of liquidity in the capital markets. Companies resort more and more to mergers and acquisitions as a quick way to innovate, add products to its portfolio, conquer market share and grow to sizes which may prevent it from being taken over. With products having ever shorter lifecycles and complexity in developing new exciting products increasing sharply, some companies are complementing in-house R&D activities with acquisitions as a way to shorten the time-to-market for new products and services.

2.1.1. The Definition of M&A

It is quite prudent at this point to clearly define what the term “mergers & acquisitions”

imply. In the literature the term M&A is treated at different levels of granularity. Picot (2002) presents M&A in the broad sense as including: the purchase and sale of undertakings; the concentration between undertakings; alliances, cooperations and joint ventures; formation of companies; corporate successions/ensuring the independence of businesses; management buy-in and buy-out; going public or IPO; change of legal form;

and restructuring. Nakamura (2005) claims the use of M&A in the broad sense leads to confusion and misunderstandings. Therefore, the author defends that a narrow sense for M&A should be used instead (presented in Figure 2–1).

Figure 2–1: Relationships between narrow and broad meaning M&A. Adapted from Nakamura (2005)

(21)

The approach taken in this work will also follow the narrow sense of M&A to avoid confusion and increase focus on the subject matter. Mergers can be defined as:

“Two or more companies joining together. The new entity can be at holding level or at company level.” (European Central Bank, 2000)

Acquisitions are defined as:

“A company buying shares in another company to achieve a managerial influence. An acquisition may be of a minority or of a majority of the shares in the acquired company.”

(European Central Bank, 2000)

The definitions above are quite generic and can be complemented (and made more specific) with help of Figure 2–1. A merger can normally be of 2 main types:



Absorption merger: a company (called the receiving company) merges with another one (the merging company), in which the receiving company keeps its corporate identity while the merging company ceases to exist as an entity. Normally the receiving company is either bigger in size or has higher brand equity in the market than the merging company.



Combination merger: the merging companies cease to exist forming a new receiving company. Normally mergers of this type take place when the merging companies are of equal size/value or have equal brand equity in the market. The new company can have a new name which resembles the merging company´s names or it can have an unrelated name. A combination merger is also called consolidation merger. A recent example is the combination of British Airways and Plc Iberia Lineas Aereas de España SA, from which the International Consolidated Airlines Group SA was formed. However, what is named a combination merger sometimes is not a real “merger” even if the receiving company´s name hints to that. A famous counterexample is DaimlerChrysler, a “merger of equals³” between the German automaker Daimler Benz GmbH and the American carmaker Chrysler Group LLC announced in May 1998. In reality, Daimler Benz acquired Chrysler⁴ (Finkelstein, 2002: 6).

Acquisitions, on the other hand, intend to impose more or less control on the acquired firm, but keeping it at an arm´s length. Acquisitions occurs when a company takes a controlling ownership interest in another firm, a legal subsidiary of another firm, or selected assets (e.g. manufacturing facilities) of another firm (DePamphilis, 2011: 15).

3 A merger of equals applies whenever the merger participants are comparable in size, competitive position, profitability and market capitalization, and so it is unclear whether one party is ceding control to another and which party is providing the greatest synergy (DePamphilis, 2011: 14)

4 In autumn 2000, DaimlerChrysler CEO Jürgen Schrempp let it be known to the world – via the German financial daily Handelsblatt - that he had always intended Chrysler Group to be a mere subsidiary of DaimlerChrysler. "The Merger of Equals statement was necessary in order to earn the support of Chrysler's workers and the American public, but it was never reality". This statement was relayed to the English-speaking world by the Financial Times the day after the original news broke in Germany.

(22)

Acquisitions can range from pure investment purposes and little control exerted on the acquired firm to hostile takeovers done by corporate raiders, whose intentions are to break the company apart, sell its parts to pay off junk bonds to finance new hostile raids (Colliins, 2001: 23). Acquisitions can be subdivided in four types:



Assets purchase and business transfers: Sometimes acquiring a target company which has a strong foothold in a market not served by the acquiring company is a quick way to get into the market immediately. A good example is the acquisition of Yoki, a Brazilian company, by the North-American General Mills in February 2012 (Vaz, 2012). After a fire destroyed General Mills´ pasta factory in Brazil, the group sold the remaining business back to their previous owners, leaving the Brazilian market. In order to take advantage of the explosive growth of the recent Brazilian food sector, General Mills re-entered the market through Yoki´s acquisition. Given the high barriers of entry imposed by the Brazilian Government, the opportunity cost of starting a new business is much higher than acquiring an established brand with immediate access to market. Similarly, companies may resort to acquisitions to expand its production capacity or refurbish an existing production plant, when a company with similar assets costs less than replacing all assets with new ones (Tobin´s Q ratio⁵). Companies can also purchase (or sell) Intellectual Properties and patents. Kodak started selling about 1,100 of its patents (about 10% of its portfolio of patents) in late 2011 to try to dodge an imminent bankruptcy (Bloomberg Business Week, 2011).



Stock acquisition: Many companies discover untapped potentials in other entities, leading them to invest in such stars through stock acquisition. Such acquirers decide how much stock to buy depending on the level of control they seek in the acquired company. Full ownership means the acquirer will hold the acquired company as a wholly-owned subsidiary, in which the management team is normally replaced partially or entirely by managers from the parent company. The decision to replace the current management team will depend on how aligned the current business strategies and management performance of the acquired company are in relation to the parent company´s expectations. When the ownership is partial (majority or minority). The acquirer tends to provide strategic management support and expertise to the acquired company´s management team when they see a potential for improvement and the current management is deemed competent. Wise CEOs recognize when merging companies incur too much risk of failure due to cultural or business grounds. When the company EMC, a storage hardware vendor, purchased VMWare, a software-based server virtualization business, in December 2003, it saw a great business potential and portfolio complementarity between both companies. However, given the different business models of both companies, EMC decided to run VMWare as a separate company. The original EMC´s business model continued to perform well, but allowed

5 Tobin´s Q is a ratio between the market value of the company assets in the capital markets and the replacement costs of such assets.

(23)

it to grow at exceptional rates⁶ due to the VMWare´s disruptive business model⁷ (Christensen et al., 2011: 54-55). It is worth mentioning that stock acquisitions can be considered friendly or hostile (called hostile takeover). It will be explained in more details in a later section.



Management Buy-in and Buy-out: these two types of acquisitions are normally a

“going-private” transaction, where a company goes from being publicly traded to private hands. In the management buy-out, the current managers of the company decide to leverage funds to take the company private (DePamphilis, 2011: 206). Normally funds come from venture capitalists and small groups of wealthy investors (hedge and pension funds for example). In the management buy-in, management of another company decides to purchase the company in the same way, so they can destitute the current management team as they assume they can do a better job than the current team.

So, the only difference is that in the management buy-out the management team already works for the company and may decide to buy it out to avoid losing their jobs.



Takeover: A takeover can be a friendly or a hostile one and normally aims at purchasing 100% of shares or at least a majority. A friendly takeover is normally welcomed by the target company´s management team, who tries to persuade its shareholders to accept the deal. The acquirer normally pays a purchase or control premium. The premium corresponds to the price paid for the controlling interest, the savings through synergies of both companies and any overpayment⁸ (DePamphilis, 2011: 16). In a friendly takeover, the acquirer submits a tender offer to the target company´s management. If the target company did not solicit the tender and it is not seeking any buyer, it constitutes a hostile tender offer. As the premiums for a friendly takeover are normally much lower than in a hostile one, companies sometimes try a friendly takeover first. If the target company rejects it, than the bidder tends to circumvent management and place a bid to buy as much shares as possible from the open market and current shareholders to gain control and dismiss the management team rejecting the takeover, constituting a hostile takeover. As it will be discussed, the target company´s management team has a number of defenses against such tactics.

6 From 2004 to 2010, EMC had a 44-fold increase on the initial investment in VMWare.

7 Disruptive business models focus on creating, refining, reengineering or optimizing a product, service, technology, industry or market (Myatt, 2009). Disruptive companies are those initial products are simpler and more affordable than the established players´ offerings (Christensen et al., 2011: 54). In VMWare´s case, it introduced a disruptive technology which replaced the expensive and inflexible vendor´s hardware solutions with lower-cost, more flexible software solutions.

8 Overpayment is the amount paid in excess of the current market value of the target company. The market value is the present value of expected future cashflows discounted at a given discount rate, which reflects the minimum rate of return expected by investors and lenders based on the level of risk faced by the business.

(24)

Cross-ownership can be used to achieve two main objectives: to demonstrate trust and long-term commitment to a working relationship⁹ between two companies (A and B), by owning each other´s shares. The second variant is to hedge losses in a merger, when A´s largest shareholders own a significant portion of A´s and also B´s shares before voting in favour of a merger. According to (Matvos and Ostrovsky, 2008), many studies show that average returns to acquiring-firm shareholders are negative, or at best, slightly positive, while average returns to target-firm shareholders are very positive, assuming both companies are publicly traded. So, why would the largest shareholders in A agree to a merger if they would lose significant amounts of their stake in A? It seems intriguing, but the reality is that they make up for the losses and even make profit with B shares. So, the shareholders with cross-ownership in A and B are sheltered from losses in A´s market value, while those without cross ownership stand to lose, especially when they don´t have enough voting rights to block the merger¹⁰.

A holding company works as an umbrella, under which one or more companies are owned fully or partially with controlling rights by the holding company. Each company is managed separately from the holding company without merging with the latter. Holding companies can be big conglomerates, such as General Electric, as well as small companies and they exist as a way to isolate liabilities incurred by one company from affecting another, and to diversify investments (portfolio theory).

A strategic business alliance is some form of contractual relationship designed to secure a national or international (global) venture without involving a shareholding (Lynch, 2009). It generally falls short of creating a separate legal entity and the agreement can be formal (legally binding) or informal (DePamphilis, 2011: 19). Equity business alliance occurs when both partners have 50% stake in the alliance. The attractiveness and relative simplicity of business alliances can be significant to justify its implementation. Many companies can join efforts to develop a unique product through combining each other´s distinct R&D capabilities and so improve their competitive advantage. Companies willing to sell their products in a region or country they are not currently present can incur prohibitive marketing and sales expenses for building production facilities and setting up distribution and sales channels. In such cases companies peer up to leverage their strengths to share existing footprint in a given market and avoid imports taxes. MillerCoors brews

9 Each company owns a small share of each other, not enough to give controlling rights. As soon as A or B own controlling rights in each other, it constitutes what was discussed in stock acquisition for the sake of owning controlling rights and eventually acquire or merge with the company.

10On October 27, 2003, Bank of America (BAC) announced plans to acquire FleetBoston Financial (FBF). In the week following the announcement, BAC´s market capitalization decreased by $9 billion, from $122 billion to $113 billion, while the FBF´s market capitalization increased by approximately the same amount, from $33.5 billion to $42.5 billion. The 10 largest shareholders of BAC owned 24% of the company and so lost more than $2 billion dollars on their BAC holdings.

The merger was subsequently approved by the BAC shareholders. 8 out of the 10 largest shareholders of BAC were also big shareholders in FBF, so that combined they lost more than $2 billion, whilst gaining over $2.3 billion from B´s shares ownership (Matvos and Ostrovsky, 2008:

391-392).

(25)

Foster´s beer in its breweries in US and use its sales channels to commercialize the product under license from Australian Foster´s Brewing International. This way, Foster´s has access to the US and Canadian markets, avoiding costly transportation costs overseas and import taxes. US and European pharmaceutical companies share distribution channels to sell drugs in both continents avoiding huge expenditures with the creation of marketing channels. Airline companies operate certain common destinations under code share agreements to increase airplane saturation and save costs, such as fuel and maintenance (Lynch, 2009: 720). Franchising is a form of license agreement that grants the franchisee the right to use the technology, business model and to sell the products under the franchiser authorization. The franchisee may get support from the franchiser in form of consulting and financing in exchange for a portion of the revenue. Notorious examples are McDonald´s, 7-Eleven and Pizza Hut.

A joint-venture involves two or more companies creating a legally independent company to share some of the parent company´s resources and expertise with the purpose of developing competitive advantage and achieve common strategic goals (Lynch, 2009:

719). To better illustrate the benefits a joint-venture can bring about, let´s briefly discuss the MillerCoors case as described in (Sottili Chaves, 2011) and (Sealover, 2009). The US beer market is considered mature and of low growth (1-3% annum) and it has been surpassed by the Chinese in volume, but it is still the single most profitable market worldwide. In 2007, Anheuser-Busch detained around 50% of the market share in US operating 12 breweries across the country. While SABMiller owned 6 breweries and 18.4% market share, MolsonCoors owned 2 breweries and 11.1% market share. With the announcement that InBev was bidding to acquire Anheuser-Busch in 2006, SABMiller and MolsonCoors decided to join forces against the giant. The joint-venture creating MillerCoors was announced in 2007 and officialised in June 2008, just a month before the creation of Anheuser-Busch InBev. The synergies achieved were outstanding:



Reduction in transportation costs

o Less half-full trucks: trucks carry products of both brands;

o Less emissions: elimination of 75 million tons of CO₂ by driving 45 million miles less as beer is brewed closer to the point of consumption;

o Less fuel, less trucks, less maintenance costs.



Stronger bargaining power with suppliers, economies of scale in procurements;



Savings by leveraging each other´s competencies;



Savings in IT systems and elimination of redundancies;



Savings were forecasted in US$400 million for the 3 years following agreement, but it achieved US$500 million in 2,5 years.

There are plenty of other examples. CAMI was a joint venture between General Motors and Suzuki (Japanese car maker). A joint assembly plant was built in Ingersoll, Canada in 1992 with the purpose of allowing Suzuki to expand in the American market and GM of learning Japanese manufacturing methods (technology transfer). The joint venture was dissolved in 2009, with GM buying Suzuki´s stake. Sony-Ericsson joint-venture was created to leverage on Ericsson´s technological strength in phone hardware and Sony´s

(26)

strength in software and cameras. Sony dissolved the venture in 2011 buying out Ericsson´s stake.

Sometimes M&A are said to be change agents, leading to corporate restructuring, which can be operational or financial in nature (DePamphilis, 2011: 2). Operational restructuring involves any of the operations within the M&A broad approach and actions such as workforce reduction/relocation, flotation¹¹, divestures (sale) of part of business or product lines, spinoffs and downsizing/closure of money-losing portions of the business. Financial restructuring are actions taken by the company to alter its capital structure¹², for example, by stock buyback program, dividend payout, to reduce borrowing costs (cost of capital), reduce taxes due by higher leverage or exhaust borrowing capacity to make a takeover less attractive.

Some companies sell off some parts of the business to leverage funds to purchase another business which has better strategic alignment or show better future prospects. For example, Siemens AG sold its Siemens VDO division (car electronic parts maker) to Continental AG (tyres maker) in 2007 to leverage cash to purchase Unigraphics (UGS) to expand its portfolio of industrial software for enabling the digital factory proposition. Other divestitures are forced on merging companies as pre-conditions to be met by anti-trust authorities. In mid-2009 the meat and poultry processing & packaging company Perdigão (already called then Brasil Foods) signed a merger with its biggest competitor, Sadia, in Brazil. In reality Perdigão acquired Sadia, which was in a difficult financial situation after losing significant amounts in the derivative markets. However CADE, the Federal Government Agency responsible for approving such transactions, imposed conditions to approve the deal, among others to sell 30% of its productive capacity to the national market and suspend sales of some brands and products for up to five years (Rodrigues, 2011).

After providing an overview of the main types of transactions or ventures under the M&A umbrella, understanding the relative risk profile of each one is of importance. The simplest dimension to analyse qualitatively is the relative risk level. It is commonplace to think that

“the higher the risk, the higher the prospect gains”, however, considering the complexities involved in each type of venture, the aforementioned “rule” cannot be taken for granted, especially without considering other dimensions. For example, a hostile takeover (by a corporate raider) can have a great return in the short term to the acquirer when the raided company is broken in pieces and sold off. However, this predatory transaction may not add anything to the acquirer in the long-run. Besides, the acquired company and the community have only to lose, due to higher unemployment and fewer taxes collected from a well-managed business.

Due to time limitations, this work will focus on the narrow sense of M&A only.

11 Flotation is the listing of a company's shares on the stock market through an initial public offering (IPO) (Financial Times, n.d.). It is known as “going public”.

12 Capital structure is the relative proportion of equity and debt held by a company.

(27)

Figure 2–2: Relative risk level (mainly risk of failure) among the many business strategies

2.1.2. Types of M&A

Understanding the types of M&A is important in many ways. For example, in determining whether a transaction infringes the anti-trust regulations, or to speculate the type of strategy is being used by a competitor. A few typologies were developed to classify M&As. In 1980, the Federal Trade Commission (FTC) in the US developed a classification system still in wide use today (Krugg, 2009: 74):



Horizontal: a company acquires or merges with another one selling the same products (same industry) in the same geographical area. This is mainly used to increase the market share (access the other company´s customers), consolidate value chain activities, increase bargaining power with suppliers, reduce capacity by eliminating redundant or inefficient assets whilst increasing saturation of existing productive assets.

Besides, the ratio fixed costs to combined revenues falls. Still mills are a good example.

Fixed costs are a big portion of the overall costs in steel production. A small dip in demand (as in 2008-2009 crises) is enough to cause losses. In such cases, as a way to survive, big steel mills purchase smaller ones, sometimes only to access the customer base. Production is consolidated in the most efficient mills and the least efficient assets are sold.



Market Extension: Companies producing the same product in different geographical area or markets. A company mergers or acquires another to have access to another market to sell its products. It is especially useful when entry barriers are high and competitors are well-established and have cost advantages. Besides, production in locus avoids import taxes. A brewery can acquire another in a distant country, producing its beer according to its recipe locally, avoiding import taxes and long distance transportation. Consolidation of value chain activities and other synergies may not be possible, as the companies operate in different geographical areas. This is especially true for perishable products. Transporting fresh milk from one region to another is expensive and may compromise quality, both from the supplier of raw milk and the finished product point of view.



Product Extension: Companies producing complementary products without competing with each other. When Procter & Gamble (P&G) acquired Gillette, one of the intentions (besides growth and market share) was to complement P&G´s Personal

(28)

Care product portfolio with Gillette´s highly profitable line of razors for both man and women. Another good example is a strategy called “financial supermarket”. Many banks trying to diversify their product portfolios to have as much market share as possible to distribute the high fix costs among different business units. All units use the same ERP and other financial systems and brokers can also represent multiple products, increasing capacity utilization and lowering the ratio fix costs to total revenue.



Vertical: Merger or acquisitions of companies in the same value chain, with a supplier (backward integration), or a customer or distributor (forward integration). Vertical integration can be worth exploring in a few situations:



When a company invested in developing a technology, production technique or trade secret, it should remain within the company to generate competitive advantage. Initially novelty production processes and techniques require expertise and “baby-sitting” to guarantee acceptable quality and yields. When such production steps are outsourced, it may cost less but it can seriously jeopardize the product quality and the company´s reputation. Therefore well-managed companies keep critical production steps under their roof and outsource the commoditized parts or components. Intel still keeps its state-of-the-art production processes in-house. Its 32-nm silicon production method is unique and a key competitive advantage to retaining its prestige in the customer´s mind in terms of performance and quality.

Apple seems to be going towards the verticalization route after the acquisition of P.A. Sami in early 2008, Intrinsity in 2010 and Anobit in 2012. The first two acquisitions are in the chip design area, giving Apple an edge by providing in-house capability to design ever more powerful processors for its smartphones and tablet computers and get ahead of its competitors, mainly Samsung. Anobit was a strategic acquisition, as Anobit is a flash memory designer (Solid State Memory), a crucial piece of hardware which is slowly replacing hard-drives, in an attempt to increase power autonomy and make thinner and lighter devices (Schonfeld, 2012). Besides, with its 95 patents, Apple would prevent its competitors from having access to such crucial competitive advantages in the hot smartphones market.



Acquiring a distributor or retailer to force selling its own branded products and not the competitor´s. Apple sells its products in boutiques (Apple Store) to increase its status as a product for the elite.



Conglomerate: A business acquires other companies in an unrelated sectors or industries. A notorious example is General Electric, which operates in several sectors:

Industrial Solutions, Health Care, Financial, Entertainment, Energy, Real Estate, Transportation and others. The holding strategy is used to make revenues more stable overtime, as negatively correlated businesses in the same portfolio can ease off variations in earnings due to seasonality or business cycle effects. For example, the Industrial Solutions Business Unit may suffer with a downturn, but this is compensated by Business Units dealing with big infra-structure projects issued by governments, such as Energy and Transportation.

(29)

Figure 2–3: Value chain representation

2.1.3. Corporate Governance and M&A

Understanding what M&A transactions are is as important as knowing who decide on pursuing such transactions, their level of authority and possible motivations (personal and professional).

Chapter 3 is devoted to show an instance of how Corporate Governance relates in practice to mergers and acquisitions. As such link is normally not explored in the literature, the reader may benefit from understanding such connection. First, Corporate Governance will be defined, its structure described and the link between Corporate Governance and M&A established.

2.1.3.1. Definition of Corporate Governance

In publicly traded companies, given the number of owners may vary from a few dozens to millions spread worldwide, it is virtually impossible for the real owners to lead the company they own. To solve this problem, managers are hired to lead the company in lieu of the owners (shareholders). Managers are expected to conduct business and make decisions on the shareholder´s behalf in a way that it is aligned with the shareholders´ best interests, i.e. to maximize the company value. However, managers are humans and they may have personal and professional interests which conflicts with those of the shareholders. In such cases, a system composed of many instruments, such as code of ethics, code of conduct and accounting standards are devised to make sure conflicts of interest are detected and removed. This system is called Corporate Governance.

The implementation and maintenance of such system is very onerous to the company.

Nevertheless, the benefits of a good governance system exceed its costs. Investors are willing to pay a premium for good corporate governance and reliable financial information, varying from 11% in Canada, 14% in US and 20% in Japan (Jamal and Jansen, 2006). The reason may be traced back to scandals such as Enron and WorldCom, which poor corporate governance allowed their management to hide the truth from investors, leading to huge losses.

2.1.3.2. Corporate Governance Structure

The Corporate Governance structure of a publicly traded company varies depending on many factors, such as the requirements set out by the Government in the country where the

(30)

company was incorporated, its size, business line, regulations of the sector it operates in, etc. An example can be seen in Figure 2–4.

Figure 2–4: Example of Corporate Governance Structure

The Board of Directors has 3 main overarching duties: define the company´s strategy, governance and oversight (Phillips and Levitin, 2010: 2). The Board of Directors sets and approves the corporate strategy and delegates its execution to the Management Board (CEO/President), which is responsible for the company´s day-to-day affairs. The Board of Directors oversees the strategy execution and intervenes if required, providing counselling to the Management Board, monitoring the management´s performance, overseeing Risk Management, among others (Phillips and Levitin, 2010: 2).

The Chairman of the Board (or Executive Director) is also elected by the Board of Directors. Vice-presidents, who will head the business units and subsidiaries, are elected by the Management Board with the Board of Directors´ blessing.

Within the Board of Directors there is an Audit Committee, responsible for managing and supervising the external auditors and the work of the Audit Function. The Nomination Committee handles the election, replacement and general “management” of the Board of Director´s members as well as its compensation scheme. Both the Audit and the Nomination Committee are governed by a respective Committee Charter, which is a document setting forth the expected committee members´ qualifications, purpose, roles and responsibilities.

The Internal Auditors are responsible to supervise the Management Board´s and its Support Unit´s conduct, accounting principles used to calculate and disclose financial figures and investments. The internal Auditors are also called the “Internal Audit Function” and report to the Board of Directors.

External Auditors are companies chosen by the shareholders to supervise the Board of Director´s work and to ensure they are acting in the shareholder´s best interest (or are obliging to their fiduciary duty towards the shareholders).

When a company is incorporated, the Corporation Bylaws and the Articles of Incorporation or Corporate Charter are filed as part of the Corporate Governance System.

(31)

The Corporation Bylaws sets forth provisions related to: number of directors, their tenure and minimum qualifications; Time and place and governance for meetings of directors, officers and shareholders; The corporation´s fiscal year; Steps to be taken in situations of conflict of interest, removal and resignation of Board Members, litigations; Set rules for approval of stocks, contracts, loans and others (The Pennsylvania State University, 2006), (All Business, n.d.).

The Articles of Incorporation or Corporate Charter sets forth what the main purpose of the company is; what it intends to do or produce; what assets it is allowed to own, build, sell and negotiate, either tangible, intangible or financial assets; the types of stocks and their characteristics and more.

The Support Unit may house executive level members that provide tactical and operational support to the CEO, such as¹³:



Chief Financial Officer (CFO): responsible for the financial policy and planning.

Large corporations normally have the Treasurer and the Controller supporting the CFO.

The Treasurer is responsible for raising cash for the company´s projects, operations and investments, and holding relationships with banks and debt holders. The Controller prepares the financial statement, internal firm´s accounting and tax obligations.

Sometimes the CFO is the Treasure and the Controller in a small/medium company (Brealey and Meyers, 2003: 6-7);



Chief Operating Officer (COO): responsible for the operations in a company, found especially in manufacturing-based companies;



Chief Technology Officer (CTO): normally seen in high-technology companies, responsible for guiding the selection of technologies to be used in its production facilities and products;



Chief Information Officer (CIO): responsible for IT infrastructure, especially of IT- sector companies;



Chief Investment Officer: responsible for the investment decisions in the company;

It is worth remembering that most of the members of the Board of Directors are normally part-time and are not employees of the company, it means they are independent and hopefully free of conflicts of interest. They act as advisors and provide constructive criticism to the Executive. In some companies the CEO is also part of the board, therefore taking part in the Strategic Plan setting.

The Corporate Governance Structure mentioned previously is valid to small, medium and large corporations. However, in smaller companies, some of the functions are covered by one person, such as the CFO being the Treasurer and Controller at the same time.

13 There are many other C-level executives depending on the company´s size, industry and country.

(32)

2.1.3.3. The Link between Corporate Governance and M&A

Shareholders hold the Board of Directors as their main proxy, who is there to defend the shareholder´s best interest. The Board of Directors provides the vision and set goals to be achieved, so that the company has a direction to go. An overarching Corporate Strategy¹⁴ is set as a main guidance, however it is the Management Board´s task to break it down into more concrete actions through a business plan, which can be refined further to define the specific actions for each business unit, in each country. The combined achievement of results of each business unit, in each country should be enough to reach the goals set by the Board of Directors. As such goals are set for the long term (3 to 5 years horizon), the Management Board will define yearly business plans and the results each year, when extrapolated, should yield the results expected by the Board of Directors.

In chapter 3, this link is cleared, when the CEO devises the strategy for achieving the overall corporate strategy and goals set by the Board of Directors. The decision to acquire or merge with another business comes from the Management Board and may be supported or rejected by the Board of Directors. According to (Phillips and Levitin, 2010), the role of the Board varies with the significance of the transaction. Directors should be highly involved in major, strategic acquisitions or sales of important assets or the entire company.

The level of involvement and diligence of the Board should increase in the same direction as shown in Figure 2–2.

Regarding mergers and acquisitions, the Board of Directors have different roles and responsibilities depending whether the company is on the buy-side or on the sell-side (Phillips and Levitin, 2010).

It is very common that members of the Board have been through mergers and acquisitions before in their tenure in other companies playing different roles. Therefore, the Board has experience in the matter and understands whether a merger or acquisition adds value to a company. The Directors have a unique vantage point in the company: they set the Corporate Strategy based on shareholders´ expectations, taking into account the market situation, and selecting/influencing the choice of Officers and Top-Management in the Business Units. Therefore, Directors are in the best position to know whether the company has to resort to a merger/acquisition to grow and if the current financial and managerial resources are sufficient to succeed in it. They also have enough experience to “feel”

whether the CEO is pushing for an acquisition for his own profit. In case the Board of Directors do not want to recognize this fact, shareholders have an important weapon against such behaviours: the Corporate Governance System. A well-set system have enough power and provisions to avoid exploitation of company resources which does not aim a maximizing its value.

14 Corporate Strategy can be defined in simple terms as the “direction an organization takes with the objective of achieving business success in the long term” (Venture Line, n.d.).

Development of a Project Management Methodology for Supporting Mergers & Acquisitions (M&A)

Development of a Project Management Methodology for Supporting Mergers & Acquisitions (M&A)

FABIO SOTTILI CHAVES

Thesis ID: 2012:141

Supervisor: Javier Sánchez

7

Edition 2010-2012

Master of Science Thesis

Stockholm, Sweden 2012

We learn wisdom from failure much more than from success. We often discover what will do, by finding out what will not do; and probably he, who never made a mistake, never made a discovery.

- Samuel Smiles

Abstract

Acknowledgements

Table of Contents

List of Figures

List of Tables

List of Acronyms

1. Introduction

1.1. Motivation







1.2. Problem Statement

1.3 Objectives and Research Contribution







Develop a Project Management Methodology to support the undertaking of mergers and acquisitions projects

1.4 Unique Contribution

1.5 Scope and Limitations

1.6 Report Outline













2. Research Background

2.1. Mergers & Acquisitions (M&A)













































